Chapter Five

Macroeconomics Abstract This chapter is separated into four major sections to address four framing questions (discussed in the text box at the end of the Summary section). First, the Macroeconomic Impacts section addresses the natural gas and oil industry’s significant impact on U.S. GDP, employment, and government revenues. Second, the Workforce Challenges section examines the aging workforce of natural gas and oil technical professionals and reviews enrollment trends in educational focus areas of importance to the

SUMMARY The benefits of plentiful natural gas and crude oil reach far beyond their use as transportation, power generation, or direct home heating fuels. Manufacturers rely on petrochemical products as building blocks for the production of electronics (including computers and cell phones), plastics, medicines (and medical equipment), cleaning products, fertilizers, building materials, adhesives, clothing, and much more. The vital role natural gas and crude oil play in almost every aspect of our personal and professional lives underscores the importance of safely and efficiently producing our domestic resources, conserving their use through energy-efficient end-use products and practices, and developing technologies to reduce the environmental impact of producing and consuming them. In addition to fueling vehicles, heating homes, generating electricity, and functioning as a necessary component of many of the products upon which people rely, natural gas and crude oil serve as a significant contributor to the U.S. economy. Companies that explore

industry. Third, the Volatility section addresses the historical drivers of natural gas and oil price variations, the impacts that price shocks can have on the economy, and the impacts of unconventional resource development on commodity price elasticity. Lastly, the Business Models section outlines the process that successful companies have used to identify and develop the U.S. natural gas and oil resources, and the government’s role in domestic natural gas and oil resource development. for, produce, refine, transport, and market natural gas and crude oil products employ millions of Americans directly and indirectly. These companies also pay taxes at the federal, state, and local levels. The natural gas and oil industry is the third largest payer of federal corporate income taxes after the manufacturing and finance industries. The natural gas and oil industry, however, faces serious challenges to its productivity and growth. Compared to other industries, the average age of the workforce in the natural gas and oil industry is older. A large gap exists between the number of retiring technical professionals and the number of graduates coming out of junior college, college, and graduate school with the knowledge and skills required to work in the natural gas and oil industry. Part of this is pure demographics as the baby boomer generation has begun to retire from the workforce. Another part is not enough industry activity on university campuses and insufficient government study grants to undergraduate and graduate-level engineering and geosciences projects that relate to the natural gas and oil industry. Despite a recent uptick in enrollments in petroleum CHAPTER 5 – MACROECONOMICS

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engineering and natural gas- and oil-focused geosciences programs, the student population will not have the raw numbers or experience to replace the number of retiring, experienced professionals. Natural gas and crude oil price volatility, like the workforce demographics, poses a challenge for the natural gas and oil industry and the consumers of its products. Crude oil remains a global commodity, subject to global supply and demand fundamentals, and – as a dollar-denominated commodity – the impact of U.S. dollar currency movements. However, natural gas, with vast domestic supplies, is more insulated from global supply and demand shocks. The development of drilling, completion, and production technologies that enable producers to unlock natural gas resources from unconventional sources has created a unique opportunity for U.S. natural gas end users. Prior to this unconventional resource revolution, uncertainty regarding expectations of future natural gas price levels led many consumers, such as electricity producers or vehicle manufacturers, to avoid becoming more exposed to natural gas price volatility. However, our nation’s unconventional natural gas resources now present end users with a more reliable source of natural gas that has the ability to be more responsive to price movements than conventional natural gas sources. The business model employed by private-sector, forprofit companies in the United States to develop our domestic natural gas and oil resources relies on many of the same fundamentals as other industries, includ-

ing free markets, rule of law, regulatory oversight, and appropriate taxation. Other countries have chosen different business models that vary from (1) somewhat similar to the U.S. model on one extreme to (2) significantly more government involvement in the development of their resources on the other extreme. The business model in the United States helps explain the success that U.S. companies (and many foreign companies operating in the United States) have had exploring for, developing, transporting, and selling natural gas and crude oil in the United States. This business model also fits well with the extensive amount of development required to produce our domestic unconventional natural gas and crude oil resources. Unconventional resources present the United States with a new opportunity to enhance its energy security, promote economic growth and environmental stewardship, and advance technological leadership in the natural gas and oil industry.

MACROECONOMIC IMPACTS OF THE NATURAL GAS AND OIL INDUSTRY ON THE DOMESTIC ECONOMY The natural gas and oil industry is an important contributor to the U.S. economy, touching almost every aspect of the energy market, including transportation, power generation, home heating, and industrial processes. The industry is a major contributor to the United States’ gross domestic

Framing Questions The Macroeconomic Subgroup of the Coordinating Subcommittee was asked to address several specific framing questions:

(and its regulators)? What steps can the industry (and the government) take to address any workforce needs?

1. What are the contributions to the domestic economy of the U.S. natural gas and oil industry?

3. What are the primary causes of natural gas and oil price volatility? What impact does this have on natural gas and oil consumers? How does this influence capital investment in natural gas and oil production and consumption technologies?

yy Employment – direct, indirect, and induced yy Economic activity yy Federal, state, and local revenues yy Regional composition and contributions. 2. What are the current age demographics in the workforce in the natural gas and oil industry

360

4. Are current industry business models adequate for the successful deployment of new domestic natural gas and oil production and end-use consumption technologies? Are new business models needed, and if so, what might they look like?

PRUDENT DEVELOPMENT: Realizing the Potential of North America’s Abundant Natural Gas and Oil Resources

Figureand 5-1.tax Largest 2010 Global GDPs Compared the U.S. Oil And Gas Industry (Billions of product (GDP), employment, labor income, Figure 5-1. Largestto2010 Global GDPs revenues to federal, state, and local governments. Compared to the U.S. Oil And Gas Industry (Billions of U.S. Dollars) In 2010, the U.S. GDP exceeded $14.5 trillion, approximately 50% larger than the next largest (but UNITED STATES $14,720 rapidly growing), the Chinese economy, as measured by purchasing power parity.1 Estimates for the comCHINA $9,872 bined operational and capital investment impacts of the domestic natural gas and oil industry on the U.S. JAPAN $4,338 economy range as high as $1 trillion of “value added” to GDP.2 Using this estimate, the domestic natural gas and oil industry is responsible for over 7% of the U.S. INDIA $4,046 economy. To put this in perspective, Figure 5-1 illustrates where the natural gas and oil industry sits relaGERMANY $2,960 tive to the GDP of the 20 largest global economies.

The natural gas and oil industry’s impact goes beyond the operations of the companies actively engaged in exploration and production (upstream), transportation (midstream), and refining and marketing (downstream) of crude oil, natural gas, and petroleum products. Through their operations and capital investment activities, natural gas and oil companies buy goods and services from suppliers and contractors, who in turn employ people and buy goods and services of their own. In addition to finding, developing, processing, and delivering critical natural gas and oil resources that fuel our economy, the natural gas and oil industry employs millions of Americans. Estimates of the total direct, indirect, and induced3 number of people in the United States employed as a result of the natural gas and oil industry range as high as 9.2 million jobs.4 Using this figure, the natural gas and oil industry is directly and indirectly responsible for approximately 6.7% of non-farm payrolls. Of these 9.2 million total jobs, 2.2 million jobs are directly engaged in upstream, midstream, and downstream activities.5

RUSSIA $2,229 BRAZIL $2,194 UNITED KINGDOM $2,189 FRANCE $2,160 ITALY $1,782 MEXICO $1,560 SOUTH KOREA $1,467 SPAIN $1,376 CANADA $1,335 U.S. OIL AND GAS INDUSTRY $1,037 INDONESIA $1,033

1 A nation’s GDP at purchasing power parity exchange rates is the sum value of all goods and services produced in the country valued at prices prevailing in the United States. 2 PricewaterhouseCoopers, The Economic Impacts of the Oil and Natural Gas Industry on the U.S. Economy in 2009: Employment, Labor Income, and Value Added, May 2011, page E-2. 3 The term “indirect” includes impacts from businesses that supply goods and services to the natural gas and oil industry. The term “induced” includes impacts from household spending of income generated either directly or indirectly from the natural gas and oil industry. 4 PricewaterhouseCoopers, Economic Impacts, page E-2. 5 PricewaterhouseCoopers, Economic Impacts, page 12.

TURKEY $958 AUSTRALIA $890 IRAN $864 TAIWAN $824 Sources: CIA World Factbook, 2010; PricewaterhouseCoopers, The Economic Impacts of the Oil and Natural Gas Industry on the U.S. Economy in 2009, May 2011. CHAPTER 5 – MACROECONOMICS

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Jobs focused on the exploration and production of domestic natural gas and oil resources, by their nature, must be performed domestically with only a few limited exceptions. They cannot be performed in another country by lower-paid labor. Also, people employed in the natural gas and oil industry, particularly those involved in exploration and production, refining and distribution, earn above-average wages. Figure 5-2 illustrates average annual wages for several of the categories of natural gas and oil industry jobs as reported by the U.S. Bureau of Labor Statistics for the most recent available data (May 2010). Estimates of total labor income (defined as wages, salaries, and benefits) from the U.S. natural gas and oil industry range as high as $534 billion.6

ally used first to estimate other direct impacts, such as gross output, value added, income, and government revenue. Then, these direct measures are fed into the IMPLAN® system (a regional economic analysis system, short for “IM”pact on “PLAN”ning) to obtain the overall impacts on all variables. In addition to reporting the direct, indirect, and induced impacts in levels, researchers also use the input-output multipliers to describe the combined impacts. For example, an employment multiplier describes the ratio between the overall number of jobs gained in the economy versus one additional job in a particular industry and/ or region. This standardized representation of the macroeconomic impact is particularly useful in comparing different studies’ findings.

Most of the studies on the North American industry’s macroeconomic impact have used input-output analysis in one way or another. Input-output models relate a specific industry’s or region’s output value to the goods and services it purchases as inputs from other industries and/or regions. In practice, a single direct impact measure, such as employment, is usu-

Input-output modeling is a powerful tool, but it does have some limitations. By its nature, inputoutput analysis relies on a static snapshot of the economy, based on fixed linear relationships between inputs and outputs that hold at a particular point in time. In reality, however, technological change modifies the technical relationships between inputs and outputs. A good example is improvements in drilling technology that require less of everything (steel,

6 PricewaterhouseCoopers, Economic Impacts, page E-2.

Figure 5-2. Oil and Gas Industry Average Annual Wages Compared to U.S. Average Figure 5-2. Oil and Gas Industry Average Annual Wages Compared to U.S. Average (U.S. Dollars) (U.S. Dollars) U.S. AVERAGE

GASOLINE STATIONS

$44,410

$21,890

PETROLEUM AND PETROLEUM PRODUCTS WHOLESALERS

$44,750

PETROLEUM AND COAL PRODUCTS MANUFACTURING

$66,280

NATURAL GAS DISTRIBUTION

$64,450

PIPELINE TRANSPORTATION

$64,820

OIL AND GAS EXTRACTION Source: U.S. Department of Labor–Bureau of Labor Statistics, May 2010.

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$77,410

drilling services, labor) for any given amount of reserve additions. In addition, input-output modeling cannot analyze directly the effect of relative prices, which lead both producers and consumers to substitute, to the extent they can, less costly goods and services, or do with less. This effect works more powerfully in the longer run. For example, expensive gasoline induces people to either drive less or replace their cars with higher mileage cars. Despite the differences in scope of analysis of various studies, industry definition, data source, and modeling treatments, the multiplier effects estimated by the studies are remarkably consistent for all three economic variables – employment, labor income, and

value added. Many of the studies include impacts of operating expenses or capital expenditures, or both. The operational impact is felt mostly in services, finance/insurance/real estate/leasing, wholesale and retail trade, transportation, manufacturing, and construction. The capital investment impact goes mainly to services, manufacturing, trade, and transportation. Table 5-1 summarizes the multipliers for several national and regional studies that analyzed impacts of both operational and capital expenditures on employment and value added. Employment multipliers ranged from 1.53 total jobs for each direct job in West Virginia (principally focuses on upstream activity in the Marcellus Shale) to 4.54 total jobs for each

Table 5-1. Summary of Multipliers Observed in Economic Impact Studies

Table 5-1. Summary of Multipliers Observed in Economic Impact Studies Value-Added Multipliers ($)

Employment Multipliers (Jobs)

State / Region

Year

Marcellus Shale Gas*

West Virginia

2008

1.53

†

West Virginia

2009

1.57

‡

Marcellus Shale Gas

Pennsylvania

2008

2.05

1.99

Marcellus Shale Gas§

Pennsylvania

2009

2.02

1.96

New York

2015

1.92

1.98

Colorado

2008

Offshore Oil and Gas

Gulf of Mexico

2007

Eagle Ford Shale Oil and Gas††

Scope Marcellus Shale Gas

¶

Marcellus Shale Gas Oil and Gas#

**

Texas

2010

‡‡

U.S. Total

2007

§§

U.S. Total

2007

Oil and Gas

Natural Gas

2.67

† ‡ § ¶ # ** †† ‡‡ §§

1.73

3.56

1.34

1.86

2.33

4.18 4.54 1.0X

*

1.48

3.5X

6.0X 1.0X

2.24 2.5X

4.0X

National Energy Technology Laboratory, Projecting the Economic Impact of Marcellus Shale Gas Development in West Virginia: A Preliminary Analysis Using Publicly Available Data, U.S. Department of Energy, March 31, 2010, page IV. Considine, Timothy, The Economic Impacts of the Marcellus Shale: Implications for New York, Pennsylvania, and West Virginia, National Resource Economics, Inc., July 2010, page 24. Considine, Timothy and Robert Watson, An Emerging Giant: Prospects and Economic Impacts of Developing the Marcellus Shale Natural Gas Play, The Pennsylvania State University, College of Earth and Mineral Sciences, July 24, 2009, pages 25-26. Considine, Timothy, Economic Impacts, pages 20-21. Considine, Timothy, Economic Impacts, page 29. McDonald, Lisa, Booz Allen Hamilton, and David Taylor, Oil and Gas Economic Impact Analysis, Colorado Energy Research Institute, Colorado School of Mines, June 2007, page XI. IHS Global Insight, The Economic Impact of the Gulf of Mexico Offshore Oil and Natural Gas Industry and the Role of the Independents, July 2010, pages 8-9. America’s Natural Gas Alliance, Economic Impact of the Eagle Ford Shale, Center for Community and Business Research, The University of Texas at San Antonio, February 2011, page 4. PricewaterhouseCoopers, Economic Impacts, page 17. IHS Global Insight, The Contributions of the Natural Gas Industry to the U.S. National and State Economies, September 2009, page 1.

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direct natural gas industry job in the United States as a whole (based on a broader analysis of the entire value chain from extraction through delivery). Valueadded multipliers ranged from $1.34 of total value added in the Eagle Ford Shale for every $1 of direct value added to $2.33 of total value added for every $1 of value added from the U.S. natural gas and oil industry as a whole. Most of the variance in multipliers for regional studies compared to broader, national studies is due to the fact that many of the domestic onshore unconventional developments are relatively new in their development (e.g., Marcellus and Eagle Ford) and the regional studies, in some cases, were published several years ago. Many states rely heavily on natural gas and oil industry participants as critically important employers and economic contributors. Since many variables beyond the presence of natural gas and oil company activity (e.g., geographic issues, presence or absence of other industries, population distribution, etc.) contribute to a state’s economic well-being, one cannot conclude that natural gas and oil industry activity alone causes a state to rank highly on employment, per capita income, or other economic comparisons. However, all of the states that rank in the top 10 in terms of natural gas and oil value added as a percent of state GDP have state unemployment rates below the U.S. national average. Six of those ten states have state GDP per capita in excess of the U.S. national average. Figure 5-3 shows the ten states with the greatest and least value-added contribution from the natural gas and oil industry as a percentage of total state GDP, and their corresponding state unemployment and state GDP per capita.

Related Industries A healthy domestic natural gas and oil industry promotes economic growth as described above and the support of an increased use of natural gas as a transportation and/or power generation fuel promotes energy security and environmental benefits. However, the growth of the domestic natural gas and oil industry, particularly that of natural gas which displaces other energy sources, could negatively affect employment and value added from industries providing other fuel sources, such as coal, and businesses that are significantly supported by the coal industry, such as large freight railroads, also called Class I railroads. 364

Coal Industry Studies that estimate the impacts of the coal industry on the domestic economy use a similar input-output model approach as studies on the impacts of the natural gas and oil industry on the domestic economy. Penn State’s 2006 study used the IMPLAN model to estimate that the coal industry will contribute, directly and indirectly, $1.05 trillion (in 2005 dollars) of gross economic output, $362 billion of annual household incomes, and 6.8 million jobs in the year 2015.7 However, the scope of the Penn State (2006) study included end users of coal (specifically, coal-fired electricity generators) in its model that generated these statistics, which complicates any comparison to PricewaterhouseCoopers’ (2011) statistics related to the natural gas and oil industry. Moore Economics, in another study using input-output modeling methodology, estimates that each coal mining job creates 3.5 additional jobs and that each $1 of direct payroll in the coal mining industry generates an additional $1.98 of indirect payroll.8 Moore Economics also estimates that the coal mining industry pays $8.1 billion in total payroll and income taxes. The electricity generation industry accounts for over 90% of the total U.S. coal consumption. As a result of this predominance, developments in the power sector directly affect the coal industry. From 2008 to 2009, domestic coal consumption decreased by 10.7% following an equivalent reduction in coalfired generation. This was due to the recession’s impact on electricity demand and, in some regions, the displacement of coal by natural gas, which benefitted from low prices.9 The narrowing price differentials between coal and natural gas observed in 2008 were further exacerbated by a rapid increase in coal spot prices that followed a surge of Appalachian coal demand from overseas during that year. (See Figure 4-14 in Chapter Four for an illustration of the megawatt hour-weighted fuel costs and coal-gas generation cost spread.) 7 Rose, A. Z., & Wei, D., The Economic Impacts of Coal Utilization and Displacement in the Continental United States, 2015, 2006, page 4. 8 Moore Economics, The Economic Contributions of U.S. Mining in 2007 – Providing Vital Resources for America, February 2009, page 20. 9 National Mining Association, 2009 Coal Producer Survey, 2010, page 1.

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365

TOP 10 STATES

Figure 5-3. Comparison of Unemployment and GDPs per Capita in States with and without a Significant Oil and Gas Presence

$35,653 $44,917 $146,359

11.1% 6.9% 9.5%

2.6% 2.2% 1.4%

MARYLAND

DISTRICT OF COLUMBIA

FLORIDA

$30,845

9.9%

2.7%

SOUTH CAROLINA

$36,252

10.0%

$46,609

$38,140

$38,437

9.7% 7.4%

$49,976

8.0%

6.3%

2.8%

2.8%

GEORGIA

VIRGINIA

2.9%

2.9%

NORTH CAROLINA

WISCONSIN

3.0%

NEW YORK

$35,000

$34,360

$32,859

9.5%

10.5%

DELAWARE

3.0%

8.1%

10.6%

NEW MEXICO

ARIZONA

7.4%

10.7%

MONTANA

$39,913

$44,970

$63,846

$42,755

$65,199

$43,032

$39,881

$61,248

6.8%

10.8%

KANSAS

STATE GDP PER CAPITA U.S. AVERAGE = $41,632

8.4%

3.6%

7.4%

11.8%

16.9%

8.1%

NORTH DAKOTA

ALASKA

22.8%

6.2%

24.3%

TEXAS

LOUISIANA

8.1%

6.1%

24.3%

27.1%

STATE UNEMPLOYMENT U.S. AVERAGE = 9.0%

WYOMING

OKLAHOMA

OIL AND GAS VALUE ADDED AS % OF GDP

Figure 5-3. Comparison of Unemployment and GDPs per Capita in States with and without a Significant Oil and Gas Presence

Sources: PricewaterhouseCoopers, 2009; U.S. Bureau of Labor Statistics, March 2011; and Bureau of Economic Analysis, 2009.

BOTTOM 10 STATES

Furthermore, economic, regulatory and, more recently, environmental concerns have led to a shift in the supply of new power generation capacity. Although coal generated approximately 45% of the nation’s electricity in 2009, approximately half of all new electric power generation capacity additions were natural gas-based. In general, coal remains the lowest cost fuel for electric power generation. That advantage is largely offset, however, by the much larger capital investments required for coal generation plants versus natural gas plants and the better efficiency rates and operational flexibility available with the latter. The cost of coal for electricity generation increased from $1.20 per million British thermal units (MMBtu) in 2000 to $2.21 per MMBtu in 2009, or 84.2%. By comparison, the cost of natural gas for electricity generation increased from $4.30 per MMBtu in 2000 to $4.74 per MMBtu, or 10.2%, although with much greater volatility than coal. That volatility was prominent in 2009, when the average delivered cost of natural gas fell by 47.5% to $4.74 per MMBtu.10 The 10 U.S. Energy Information Administration, Electric Power Annual.

historical volatility in natural gas prices has been a disadvantage in comparison to coal as a fuel for electricity generation. The increase in the elasticity of supply of natural gas due to technological innovation has the ability to mitigate this historical disadvantage. In 1996, natural gas-fired power generation capacity accounted for 23.5% of total installed capacity in the United States. In September 2010, that share had grown to 40.8%. In fact, while coal-fired installed capacity has remained largely unchanged over the last 20 years, natural gas-fired capabilities have almost tripled. Productivity improvements, efficiency measures, environmental concerns, regulatory challenges, and other factors have contributed to the 40.4% decrease in coal mining employment from 1988 to 2008. Figure 5-4 illustrates the significant decline in direct coal mining employment from 1988 to 2008. According to the Bureau of Labor Statistics, the median earnings for people in the coal mining industry were $23.11 per hour for the May 2010 period, the latest for which data are available. This equates to approximately $48,069 per year.

Figure 5-4. Direct Employment in the Coal Mining Industry

Figure 5-4. Direct Employment in the Coal Mining Industry

EMPLOYEES (THOUSANDS)

OFFICE WORKERS INDEPENDENT SHOPS AND YARDS

120

PROCESSING PLANTS MINING – SURFACE AND UNDERGROUND

1,200 1,000

DOMESTIC COAL PRODUCTION (MILLIONS OF TONS)

800 80 600 400

40

200 0

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

YEAR Source: Based on National Mining Association, “Mining Industry Employment in the United States by Sector, 1985–2008,” January 2010; Energy Information Administration.

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PRUDENT DEVELOPMENT: Realizing the Potential of North America’s Abundant Natural Gas and Oil Resources

0

COAL PRODUCED (MILLIONS OF TONS)

1,400

160

Railroad Industry Domestic coal production is focused on a few key coal-rich areas like the Appalachian Mountain and the Rocky Mountain regions and several Midwestern states. However, coal is consumed widely across the country. The United States’ extensive railroad system accounts for approximately 70% of coal deliveries and makes this wide distribution of coal logistically possible and cost-effective. In 2008, coal accounted for approximately 25% of carloads, 45% of tonnage, and 23% of the $60.5 billion of gross freight revenue for the Class I railroads.11 Clearly, the performance of the railroad industry and the coal industry are linked. By comparison to the figures previously mentioned for the coal and the natural gas and oil industries, the U.S. freight railroad industry employed 183,743 people in 2008 who earned an average of $71,303 in 2008.12

Taxes and the Natural Gas and Oil Industry Aside from the economic benefits the consuming public derives from the natural gas and oil industry in the forms of employment, value added, and resource availability, the industry also benefits the public by paying a significant amount of taxes. Literature on the topic of taxation refers to total “government take,” or the total amount of revenues that the federal, state, and local governments collect in all forms of taxes or revenue receipts from the industry. Much of the information available on total “government take” from the natural gas and oil industry focuses on the upstream exploration and production sector. These companies pay the standard federal and state corporate income taxes that firms in other industries pay. Upstream companies also pay severance and ad valorem taxes based on the amount of hydrocarbons they produce and pay bonuses and royalties to the owners of the mineral interests from whom they are leased. The largest of these mineral interest owners are federal and state governments. For 2007, direct payments by natural gas and oil corporations to the federal and state governments were approximately $50 billion: $29.8 billion in federal corporate income taxes, $10.7 billion in state severance taxes, and $9.4 billion in federal royalties. 11 Association of American Railroads, “Railroads and Coal,” 2010, page 1. 12 Association of American Railroads, “Class I Railroad Statistics,” 2010, page 4.

In addition, natural gas and oil companies pay significant amounts in other forms of taxes, including excise fuel taxes, sales, property, and use taxes ($86 billion), and by generating employment income they indirectly support federal, state, and local governments ($140 billion). Once all of these sources of government revenue are added together, they amount to approximately $276 billion for our 2007 reference year. This total does not include excise and other taxes levied by states and localities on piped natural gas, and several other industry products.

Federal Corporate Income Taxes Corporate income taxes are a function of a company’s taxable income, the rate at which that income is taxable and any tax credits available to the company. The natural gas and oil industry as a whole has been taxed at a steady rate of around 35%, with tax credits varying slightly over the years. Figure 5-5 illustrates the annual federal corporate income taxes paid by natural gas and oil corporations. The wide variations in federal corporate income taxes paid since 2001 are mostly due to changes in taxable income. The industry represents a growing share of the federal government’s tax revenue. In 2007, the natural gas and oil industry contributed to 9% of the U.S. government receipts from active corporations, up from 2% in 2002. The vast majority of those receipts come from refiners (65% in 2007). Extraction activities come in second at 16%. When compared to all other industry segments reported by the IRS, the natural gas and oil industry ranks third out of 20 broad industry segments. Figure 5-6 illustrates the contributions of each industry group to the total federal income taxes paid by corporations.

Severance Taxes Twenty-seven states collect severance taxes from natural gas and oil producers. Table 5-2 highlights the 16 states that receive over 1% of their state tax collections from severance taxes. The remaining states either do not collect severance taxes or their severance tax collections account for less than 1% of their total state tax collections. The increased drilling activity targeting the Marcellus Shale in the New York, Pennsylvania, and West Virginia region has prompted Pennsylvania to review CHAPTER 5 – MACROECONOMICS

367

Figure 5-5. Federal Income Taxes Paid by Corporations

Figure 5-5. Federal Income Taxes Paid by Corporations 100 GASOLINE STATIONS PETROLEUM AND PETROLEUM PRODUCTS WHOLESALERS PETROLEUM AND COAL PRODUCTS MANUFACTURING NATURAL GAS DISTRIBUTION OIL AND GAS EXTRACTION

BILLIONS OF U.S. DOLLARS

30

20

OIL (WTI) GAS (HH)

80

60

40 10 20

0

2001

2002

2003

2004

YEAR

2005

2006

2007

2008

DOLLARS PER BARREL OR PER MMBTU

PIPELINE TRANSPORTATION

0

Notes: HH = Henry Hub, used as the point of delivery for the natural gas futures contract of the New York Mercantile Exchange (NYMEX). WTI = West Texas Intermediate. Source: U.S. Department of the Treasury.

its alternatives for balancing priorities of supporting communities in which extraction activities take place and of enabling natural gas and oil companies to operate competitively within the state. Pennsylvania Governor Corbett assembled an advisory commission to recommend a solution to address these priorities. In July 2011, this commission recommended that Pennsylvania institute a drilling impact fee in lieu of a severance tax.

Royalties Producers of natural gas and crude oil pay royalties to the owners of the mineral rights for the privilege of extracting the resources. Royalty rates vary by commodity and by jurisdiction and are applied to gross revenues from the sale of natural gas and oil. Onshore, the federal government charges a statutory minimum of 12.5% royalty, and offshore, the royalty rate ranges from 12.5% to 18.75%. Under the Mineral Revenue Management program, the Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE, formerly known as the Minerals Management Service) collects, accounts 368

for, and distributes revenues associated with offshore and onshore oil, gas, and mineral production from leased federal and American Indian lands. Figure 5-7 shows the reported royalty revenues collected by the BOEMRE for crude oil, natural gas, and NGLs from 2001 to 2009. The 45% decrease in royalty revenue in 2009, compared to 2008, resulted from the decrease in crude oil and natural gas prices, which averaged $61.99 per barrel and $4.94 per thousand cubic feet (Mcf) in 2009, respectively, compared to $99.92 per barrel and $8.89/Mcf, respectively, in 2008. The BOEMRE collected over $72 billion from 2001 to 2009. Each year, the BOEMRE disburses its revenue to states, counties, parishes, the U.S. Treasury, American Indian Tribes, individual American Indian mineral owners, the Reclamation Fund for water projects, the Land and Water Conservation Fund, and the Historic Preservation Fund. In fiscal year 2009, the BOEMRE disbursed approximately $10.7 billion from revenues collected from energy and mineral production on federal and American Indian lands. Thirty-five states received a total of almost $2.0 billion directly from the BOEMRE as part of this disbursement.

PRUDENT DEVELOPMENT: Realizing the Potential of North America’s Abundant Natural Gas and Oil Resources

5-6.Federal 2007 Taxes Federal Paid by Corporations FigureFigure 5-6. 2007 PaidTaxes by Corporations (Millions of U.S. Dollars) (Millions of U.S. Dollars)

MANUFACTURING EXCL. PETROLEUM PRODUCTS MANUFACTURING

$61,113

FINANCE AND INSURANCE

$36,531

OIL AND GAS INDUSTRY

$29,816

RETAIL TRADE EXCL. GASOLINE STATIONS

$19,914

MANAGEMENT OF COMPANIES (HOLDING COMPANIES)

$17,919

WHOLESALE TRADE EXCL. PETROLEUM AND PETROLEUM PRODUCTS

$17,415

INFORMATION

$17,016

PROFESSIONAL, SCIENTIFIC, AND TECHNICAL SERVICES

$6,395

TRANSPORTATION AND WAREHOUSING EXCL. PIPELINE TRANSPORTATION

$5,232

MINING EXCL. OIL AND GAS EXTRACTION

$4,993

UTILITIES EXCL. NATURAL GAS DISTRIBUTION

$4,462

CONSTRUCTION

$3,695

HEALTH CARE AND SOCIAL ASSISTANCE

$2,822

ADMINISTRATIVE AND SUPPORT, AND WASTE MANAGEMENT AND REMEDIATION SERVICES

$2,700

ACCOMMODATION AND FOOD SERVICES

$2,370

REAL ESTATE AND RENTAL AND LEASING

$2,274

EDUCATIONAL SERVICES

$738

OTHER SERVICES

$680

AGRICULTURE, FORESTRY, FISHING, AND HUNTING

$591

ARTS, ENTERTAINMENT, AND RECREATION

$549

Source: U.S. Department of the Treasury. CHAPTER 5 – MACROECONOMICS

369

Table 5-2. 2007 State Severance Taxes Collections (U.S. $ Millions)

As a % of State Tax Collections

10,728.9

1.4%

144.2

1.6%

United States Alabama Alaska

Rank 13

2,216.0

64.4%

1

Colorado

136.9

1.5%

14

Kansas

132.3

1.9%

11

Kentucky

275.3

2.8%

10

Louisiana

904.2

8.3%

7

Mississippi

81.8

1.3%

15

Montana

264.7

11.4%

5

Nevada

62.2

1.0%

16

New Mexico

843.9

16.2%

4

North Dakota

391.3

21.9%

3

Oklahoma

942.1

10.6%

6

Texas

2,762.9

6.9%

9

Utah

101.5

1.7%

12

West Virginia

328.3

7.1%

8

Wyoming

803.6

39.7%

2

Source: National Conference of State Legislatures.

Figure 5-7. Reported Royalty Revenues

Figure 5-7. Reported Royalty Revenues 14 605

BILLIONS OF U.S. DOLLARS

NATURAL GAS LIQUIDS NATURAL GAS CRUDE OIL

285

10 286

206

6

5,358

183 156

240

0

2,363

2001

5,818

80

5,766

4,644

5,151

4,770

258 6,172

2,737

40

4,235

2,749

2

368

3,977

4,401

3,838

2,594

1,872

1,553

1,539

2002

2003

2004

2005

2006

2007

2008

2009

YEAR Notes: HH = Henry Hub, used as the point of delivery for the natural gas futures contract of the New York Mercantile Exchange (NYMEX). WTI = West Texas Intermediate. Sources: Bureau of Ocean Energy Management; John S. Herold, Inc.

370

PRUDENT DEVELOPMENT: Realizing the Potential of North America’s Abundant Natural Gas and Oil Resources

0

DOLLARS PER BARREL OR PER MMBTU

120 OIL (WTI) GAS (HH)

Other Taxes Generated Directly by the Industry The natural gas and oil industry pays significant federal and state excise taxes on fuels. The combined weighted average tax rates per gallon were 38.6 cents for gasoline and 45.2 cents for diesel in 2007.13 Applied to the 139 billion gallons of gasoline and 40 billion gallons of diesel sold in 2007, these tax rates generated approximately $72 billion, which is the largest tax item paid by the industry and, ultimately, by gasoline and diesel consumers. Natural gas and oil companies also pay significant amounts of sales, use, and property taxes, which were estimated at $3.2 billion in 2007.14 However, this is not the full story. Most gasoline stations are not directly owned by natural gas and oil companies, and convenience stores associated with gas stations sell approximately $180 billion of non-fuel merchandise.15 Applying the national sales tax average rate of 7.3% to that amount provides an estimate of $13 billion in sales taxes generated by the broader natural gas and oil retail industry.

Tax Deductions for the Natural Gas and Oil Industry A review of the tax burden on the natural gas and oil industry would be incomplete without referencing the tax deductions used solely by the industry or directed towards multiple industries, including the natural gas and oil industry. President Obama’s 2012 budget includes proposals to eliminate eight of these tax deductions and one natural gas and oil research and development (R&D) program. Several of these tax deductions proposed for elimination are specific to the natural gas and oil industry (e.g., the ability to expense rather than capitalize intangible drilling costs). Other tax provisions targeted for elimination, such as the domestic manufacturing deduction, are available to multiple industries, but the president proposes targeting the natural gas and oil industry (and the coal industry) to end their use of the deduction. According to President Obama’s 2012 budget, eliminating these 13 Federal Highway Administration, February 2008 Monthly Motor Fuel Reported by States, 2007. 14 American Petroleum Institute, “America’s Oil and Gas Industry: Paying Their Share,” 2010. 15 National Association of Convenience Stores.

eight tax deductions and one R&D program will generate over $43 billion in additional tax revenue over the next 10 years. Eliminating these tax provisions will reduce investment in domestic production across the industry by reducing company cash flow available for investment and making some domestic projects uneconomic. These provisions are particularly important for independent exploration and production companies that, on average, outspend their cash flow from operations by drilling new wells or acquiring new properties. Without these tax provisions, these companies would have less capital available to invest in their businesses. Table 5-3 summarizes the tax deductions and the R&D programs that are proposed for elimination. Supporters of the elimination of these tax deductions argue that they primarily benefit multibillion-dollar oil companies that would remain profitable without these tax deductions.16 Opponents of the elimination of these tax deductions maintain that this system has evolved over time to direct capital to critical industries to develop our domestic resources and mitigate our dependence on foreign sources of fossil fuels.17 Wood Mackenzie analyzed the impacts of the elimination of two of the tax deductions: the expensing of intangible drilling costs and the domestic manufacturing tax deduction for natural gas and oil companies. This analysis included the evaluation of the economic viability of 230 discrete domestic natural gas and oil plays under current commodity price conditions. Assuming that natural gas and oil companies lose both the manufacturing tax deduction and the ability to expense intangible drilling costs, Wood Mackenzie estimates that the average natural gas price needed to achieve a 15% internal rate of return would increase by $0.60/Mcf to $6.00/Mcf. Using this 15% internal rate of return as the breakeven threshold puts approximately 3 billion cubic feet per day of incremental natural gas production at risk in 2011 and 27 trillion cubic feet of natural gas resources at risk through 2020.18 Another provision proposed by the Senate to be repealed would further limit foreign tax credits and subject only U.S.-based natural gas and oil companies 16 Gandhi, S. J., Eliminating Tax Subsidies for Oil Companies, Center for American Progress, 2010. 17 Hodge, S. A., Who Benefits Most from Targeted Corporate Tax Incentives? Tax Foundation, 2010. 18 Wood Mackenzie, Evaluation of Proposed Tax Changes on the US Oil & Gas Industry, commissioned by the American Petroleum Institute, 2010, page 4. CHAPTER 5 – MACROECONOMICS

371

Table 5-3. Summary of Proposed Federal Budget Elimination Impacting the Natural Gas and Oil Industry (Millions of U.S. Dollars) 2012

2013

2014

2015

2016

2012–2016

2012–2021

(3,492)

(5,400)

(4,908)

(4,631)

(4,586)

(23,017)

(43,762)

Repeal enhanced oil recovery credit

0

0

0

0

0

0

0

Repeal credit for oil and gas produced from marginal wells

0

0

0

0

0

0

0

(1,875)

(2,512)

(1,762)

(1,403)

(1,331)

(8,883)

(12,447)

Repeal deduction for tertiary injectants

(6)

(10)

(10)

(10)

(10)

(46)

(92)

Repeal exception to passive loss limitations for working interests in oil and natural gas properties

(23)

(27)

(24)

(22)

(21)

(117)

(203)

Repeal percentage depletion for oil and natural gas wells

(607)

(1,038)

(1,079)

(1,111)

(1,142)

(4,977)

(11,202)

Repeal domestic manufacturing tax deduction for oil and natural gas companies

(902)

(1,558)

(1,653)

(1,749)

(1,842)

(7,704)

(18,260)

Increase geological and geophysical amortization period for independent producers to seven years

(59)

(215)

(330)

(306)

(230)

(1,140)

(1,408)

Terminate oil and gas research and development program

(20)

(40)

(50)

(30)

(10)

(150)

(150)

Total proposed changes from current law

Repeal expensing of intangible drilling costs

Source: Office of Management and Budget, Fiscal Year 2012 – Terminations, Reductions, and Savings: Budget of the U.S. Government, pages 52–53.

to double taxation of foreign earnings. This would make domestic companies less competitive than their foreign-based counterparts in the United States and abroad. The natural gas and oil industry is not the only energy-related industry to benefit from federal tax deductions. In fact, as a percentage of total U.S. consumer spending by energy source, the natural gas and oil industry is among the lowest recipients of federal tax deductions or subsidies compared to other energy sources. Table 5-4 summarizes the estimated federal 372

government taxpayer incentives by energy source as a percentage of total U.S. consumer spending on each energy source in 2006.

NATURAL GAS AND OIL WORKFORCE CHALLENGES Like most industries, the natural gas and oil industry is experiencing the initial stages of a large wave of retirements as the oldest members of the baby boomer generation (those born between 1946

PRUDENT DEVELOPMENT: Realizing the Potential of North America’s Abundant Natural Gas and Oil Resources

Table 5-4. Estimated Federal Government Financial Incentives by Energy Source in 2006* (Millions of U.S. Dollars) Government Financial Incentives per Million Btu of Consumption

Government Financial Incentives

Total Spending on Energy Source

Government Financial Incentives as a Percent of Total Spending

Ethanol

$4,708

$17,791

26.5%

$10.13

Nuclear

$1,187

$5,694

20.9%

$0.14

Solar

$383

$3,114

12.3%

$5.32

Wind

$458

$3,960

11.6%

$1.73

$92

$933

9.9%

$2.80

$2,755

$39,984

6.9%

$0.12

$295

$56,419

0.5%

$0.10

$29

$5,854

0.5%

$0.09

$3,503

$775,907

0.5%

$0.06

$210

$50,631

0.4%

$0.06

Energy Source

Biodiesel Coal Hydroelectric Power Geothermal Natural Gas and Oil† Biomass

* Federal fiscal years run from October 1 to September 30. † Natural gas and oil includes natural gas, crude oil, and natural gas liquids plant production. Source: Energy Information Administration and Texas Comptroller of Public Accounts.

and 1964) reach age 65 this year. Similar to most industry sectors dependent on a robust technical workforce, the natural gas and oil industry faces crucial challenges in replacing that talent, particularly highly skilled technical positions such as petroleum engineers and geoscientists. University-level programs that directly feed into natural gas and oil careers have contracted over the past several decades, resulting in a supply of new employees that will be unable to replace the talent vacated by baby boomer retirements. The recession that ended in June 2009 (according to the U.S. National Bureau of Economic Research) negatively impacted retirement savings for many baby boomers and thus delayed their ability and/or willingness to retire. This recession thus may have deferred the onset of critical shortages of talent and provided a narrow window to enable appropriate knowledge transfer and development for younger workers. However, the recession, combined with weak natural gas prices in the United States, also led to a decrease in recruiting efforts by natural gas and oil companies and limited the rate at which companies

took on new hires that would have allowed them to leverage the delayed retirements. As seen in the student response to contraction in the 1980s, and in student attitude surveys taken of geosciences majors, when the industry limits its hiring, that trend is quickly communicated within the student community. This, plus existing prejudices against natural gas and oil careers by students, further dissuades them from degrees that map to the needs of the industry. This process can often limit the potential new hires market for nearly a decade, as impacted high school and college students enter the workforce six to ten years later.

Challenge #1 – Aging Natural Gas and Oil Workforce The natural gas and oil industry relies heavily on petroleum engineers and geoscientists to explore for, evaluate, and quantify subsurface natural gas and oil resources. As Figures 5-8 and 5-9 illustrate, a significant percentage of the petroleum engineer and geologist population is within 10 years of retirement. Also of note, approximately 52% of Society of Petroleum Engineers (SPE) members are in the baby boomer CHAPTER 5 – MACROECONOMICS

373

Figure 5-8. Age Distribution of Society of Petroleum Engineers (SPE) Membership usedof asPetroleum Figure ES-12Engineers (SPE) Membership Figure 5-8. Age Distribution ofALSO Society 20

PERCENT OF SPE MEMBERSHIP

1997 15

10 2010

5

0 0